Oshkosh Takes A Blow From Planned Defense Budget

President Obama submitted his 2013 budget to Congress today. It reflects some realities of current government spending at this time with plans to hold some spending flat and reduce the deficit slightly. It does also include some proposed tax increases and reforms. The budget will probably get a poor reception by Congress but it does, especially with some of the planned spending, lay out some broad guidelines.

One area that saw limited growth was the U.S. defense budget. Part of this was due to the planned cut backs in commitments to Afghanistan and part was due to reduced spending on certain programs. These include cuts in some procurement and investment programs, reducing the size of the armed forces and personnel costs and benefits. Total investment spending was cut roughly $10 billion from 2012 with certain programs being singled out.

One of the major reductions is to the U.S. Army's planned purchase of trucks. These are made by Oshkosh Corporation (NYSE:OSK) who successfully won the contract from BAE Systems (BAE) in 2009. The Family of Medium Tactical Vehicles (FMTV) are the standard truck and trailer combination used by the Army and Marine Corps for utility and transport. The Army had planned on investing in thousands to replace those damaged or destroyed in Iraq and Afghanistan. Now due to the decline in requirements the plan is to eliminate $2.2 billion of spending over the next 5 years starting with an initial $100 million cut in 2013.

The FMTV contract is for five years and several thousand vehicles with the options to extend it even further. In order to win the FMTV contract Oshkosh had to price it very aggressively with their margins cut to the bone. It had hoped to make some money on potential modifications and additions to the program but those have not materialized.

Oshkosh also was able to win a contract to produce the Mine Resistant Ambush Protected-All Terrain (MRAP-AT) for use in Afghanistan. This contract has generated billions in revenue and profits for the company but it was for a fixed number of vehicles and that is winding down.

Oshkosh's core business had suffered with the downturn in the world economy and had entered defense contracting to make up some of that lost business. With the company's reduced investments, the housing crisis and less government spending Oshkosh saw declines in demand for construction equipment and its emergency vehicles.

The stock had been down to $10 in 2009 from a recent high of $60 in 2007. It did recover some but over the last twelve months it has drifted from the high $30's to yefsterday's close at $23.67. For the most recent quarter it reported earnings of 42 cents above analyst expectations of 33 cents and is now trading at a P/E of almost 11 times. The company stated that profit was reduced due to falling defense sales.

The company is also facing pressure from wildcat investor Carl Icahn who would like to see it merge with competitor Navistar (NYSE:NAV). Navistar has performed better over the last few years. Icahn owns about 10% of OSK stock and has been pressuring the company to agree to the merger. He recently tried to add directors but at the January 27th shareholder meeting these plans were beaten back with 5 of his 6 proposed candidates rejected. That does not mean the market isn't talking up the merger idea. There are some who see it an ideal way to spread the pain of the defense budget cuts.

The stock fell over a dollar yesterday and certainly in the short term it will continue to fall as the company now faces revenue issues. If the idea of merging with Navistar gains ground then it might rally as Morningstar estimates the target price for Navistar at $43.00 to $46.00 or twice the current price. Without the merger going through the stock should languish for at least several months as Oshkosh works out balancing the defense cuts with an increase in their commercial vehicles as the economy recovers.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.